Getting the most for your money

Five valuable tax perks you don't want to miss when you file 2007 taxes

SAN FRANCISCO (MarketWatch) -- Whether you use a professional tax-return preparer, a software package or struggle yourself with paper and pencil, it pays to take note of the most valuable tax credits and deductions.

In big-picture terms, personal exemptions offer the biggest value, worth $842 billion in total dollars claimed on 2005 returns, according to the IRS. While it's unlikely taxpayers miss out on their rightful exemptions, there are plenty of other tax perks they do often miss.

1. Educate yourself

Any education expenses you paid in 2007 might result in one or more tax perks, including the Hope credit, Lifetime Learning credit and tuition deduction, if you fall within the income guidelines.

Yet about one-fourth of eligible taxpayers neglected to take the Hope or Lifetime Learning credit available to them, according to a review of about 1.4 million tax returns by the U.S. Government Accountability Office in a report dated July 2005. The money lost as a result was relatively small, about $169 on average. But 10% of those filers paid $500 more than necessary in taxes, according to the GAO.

The Hope credit, worth up to $1,650, applies to tuition and related fees (books and supplies and room and board are not covered) incurred during the first two years of higher education. The Lifetime Learning credit is worth up to $2,000 of qualified expenses, for any year of higher education.

Both credits start phasing out for filers with modified adjusted gross income of $47,000 ($94,000 for married-filing-jointly), and both credits drop to zero for those with a MAGI of $57,000 ($114,000 for married-filing-jointly).

You don't have to itemize to take the above-the-line tuition and fees deduction, worth up to $4,000, but your modified adjusted gross income must be no more than $65,000 for single filers ($130,000 for married-filing-jointly). Then, the deduction drops to $2,000 for single filers with MAGI from $65,000 to $80,000 ($130,000 to $160,000 for married-filing-jointly), after which it disappears entirely.

You can't take the deduction if you take one of the credits. Generally, a credit is more valuable than a deduction, but given phase-outs and other considerations, taxpayers with higher-education expenses should run the numbers to see which tax perk yields the most savings.

2. Standard deduction or itemize?

One of the highest-value tax decisions is whether to itemize or to take the standard deduction, which for 2007 returns is $10,700 for married-filing-jointly filers, $7,850 for head-of-household filers, and $5,350 for single filers.

In 2002, the GAO, Congress's investigative arm, found that taxpayers who could have itemized but didn't sacrificed $945 million, or about $438 per taxpayer on average. About one-third of taxpayers itemize each year.

"People sometimes won't itemize," because of the extra work involved, said Bob Scharin, a New York-based senior tax analyst with RIA, of Thomson Tax & Accounting. "They have to go and search for things [and] they wait to the last minute, and then they say 'I wanted to get to bed tonight,'" he said. Taxpayers "should get these numbers together before they go on the computer."

Homeowners can relatively easily judge whether itemizing is worth it: Add up what you paid for mortgage interest, real estate taxes and state and local income taxes, and compare against the standard deduction. If you're 65 or older, note that there's an additional amount to add on to your standard deduction: $1,050 for married filers and $1,300 for single filers.

Even renters might have reasons to itemize. "That renter might have trustee fees, might have fees for investment advice, might have extraordinary medical bills" all of which are deductible expenses, said Grace Allison, tax strategist with Northern Trust in Chicago.

Others agreed. "If you're renting it doesn't preclude you from itemizing, it just affects the types of deductions you have," said Greg Rosica, tax partner with Ernst & Young. "You could have sales taxes or state income taxes, charitable contributions, or investment expenses that you might be able to use."

For instance, itemizers can choose to deduct state sales taxes in 2007 in lieu of state income taxes. That's a valuable perk for residents in states such as Florida and Texas, which have no income tax, and for taxpayers in other states who pay low income taxes.

3. Get credit where credit's due

Since they provide a dollar-for-dollar reduction of your tax bill, credits are generally more valuable than deductions. In addition to the education credits, consider the child tax credit, worth $1,000 for each child up to age 17, if you qualify.

Also, parents should assess whether they can take the credit for dependent and child care expenses, including day-care and summer day-camp costs (but not sleepover camp) -- a perk that can reduce your tax bill by as much as $2,100.

4. Big benefit for business owners

Business owners who bought equipment such as computers, trucks, or furniture (with some limitations), don't want to miss out on the Section 179 expense election, worth up to $125,000 in 2007. "It's probably the most valuable extra deduction there is," said Ted Lanzaro, managing partner with Shelton, Conn.-based Lanzaro CPA, and "you don't necessarily have to lay out the money to do it." A contractor might decide to buy two new trucks, financing most of the cost. "In essence I've used Ford Motor Credit to give me a $60,000 deduction without me spending the $60,000," he said.

Another benefit: The deduction can be used to reduce a spouse's taxable income. "Let's say I'm the contractor and my wife has a W-2 job somewhere. My section 179 depreciation, even though I've taken it to zero, I can use it to offset her W-2 income," Lanzaro said.

"Especially with people starting businesses, they start a business, they're not making so much money but it's a capital-intensive business, we'll take the Section 179 and zap their spouse's income almost down to zero for it. It's a very, very good strategy," he said.

5. Charitable donations

Taxpayers can deduct up to 50% of adjusted gross income for their charitable efforts, but plenty of taxpayers fail to enjoy the full benefits of this deduction, Lanzaro said.

"Many people come back to me later and say, 'Oh, I forgot I gave that big box of clothes to Goodwill,'" he said. Before sitting down to do your 2007 taxes, gather all receipts and look through your checkbook to ascertain all of your charitable giving.

Taxpayers enjoyed about $172 billion worth of charitable-contribution deductions in 2005, according to the IRS. And this deduction comes in as the fourth most valuable among taxpayers who itemize, according to an analysis by CCH, said Mark Luscombe, a principal analyst with CCH Inc., a Riverwoods, Ill., tax publisher.

For 2007 the rules got a bit tighter. Before, taxpayers needed a bank record or written receipt from the recipient for cash donations of $250 or more, but now that proof is required for cash donations of any amount.

If you donated used items, such as furniture or clothes, those items must be in "good" or better condition, according to the IRS. "If you've given away useful clothing, then typically you can list the item at its original cost when you bought it and you can take 25% of the original cost and deem that to be the thrift shop value and that's the deduction you can take," said Leo Bruette, a tax partner with BDO Seidman, Bethesda, Md.

Plan ahead

Some of the most valuable tax perks require some planning ahead. While you're thinking about tax savings, consider that one of the best ways to reduce your taxable income is to put more money into a 401(k) or individual retirement account.

"Any one person can make a gift to any other person for up to $12,000, the person receiving it doesn't have to pay any income tax on it," Eisenberg said. "We are in an economic slowdown at this point. If a parent wants to help out a kid or a grandparent wants to help a grandkid, these tax-free gifts are a tremendous help."

If you keep the gift below $12,000, there is no need to report the gift or to file a gift tax return.

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